May292014

Growth Gap Remains Large

The Bureau of Economic Analysis (BEA) estimated that real gross domestic product (GDP) declined at an annual rate of 1.0% during the 1st-quarter 2014. BEA had estimated that real GDP had advanced by 0.1% in its first estimate of 1st-quarter GDP.

Today’s release was disappointing on several fronts. While the unusually cold and snowy winter had a negative effect on growth in the quarter, most forecasters estimate that the weather related “lost growth” will be made up in the 2nd-quarter. For example, Macroeconomic Advisers has estimated that the weather subtracted 1.4 percentage points from growth in the 1st-quarter, but would add 1.6 percentage points to growth in the 2nd-quarter. Even without the “weather effect” growth during the quarter would have been barely positive.

Since the recession ended in June 2009, real GDP has increased by a total of 10.8% over 19 quarters. That equates to annualized growth of 2.2%. That compares rather unfavorably with the average of other post-1960 recoveries when the annualized growth rate over the comparable period was 4.1%. During the strong Reagan recovery of the 1980s, annualized growth over the comparable 19 quarters was 5.0%. If this recovery had merely been average, real GDP would be $1.5 trillion larger. A Reagan-style recovery would have added $2.1 trillion to real GDP.

Getting back to average will not be easy. In order to get back to average, real GDP would need to grow at an annual rate of 6.3% through the end of 2016. To catch up to the Reagan recovery, the annualized growth rate would need to come in at 8.4% through the end of 2016.

Inside Today’s Report

Real personal consumption expenditures (PCE) rose at an annual rate of 3.1% during the quarter and added 2.09 percentage points to the growth rate. On the negative side of the ledger, the change in private investment in inventories subtracted 1.62 points from the growth rate, while fixed non-residential investment (0.20 percentage point) and residential investment (0.16 percentage point) also subtracted from the growth rate. Net exports subtracted 0.95 percentage point.

Federal government consumption and investment added 0.05 percentage point to growth, while state and local government consumption and investment subtracted 0.20 percentage point from growth.

While the 3.1% annual growth in real PCE appears to be the bright spot in today’s report, a look at the underlying detail paints as less rosy picture. As Wells Fargo pointed out in its comments on the BEA report, most of the PCE growth “came from services outlays, which were driven primarily by the implementation of the Affordable Care Act that boosted payments for health insurance. While this growth does reflect actual activity, the timing reflects the political calendar and not the economy’s underlying momentum. Without the bump in healthcare outlays, consumer spending would have risen at just a 2.1 percent pace and real GDP would have tumbled at a 2.0 percent pace. That would have been a pause that truly depressed overall economic growth” (emphasis added).

Of the 2.09 percentage points that PCE added to the growth rate, roughly half (1.01 percentage points) came from increased spending on health care services. Over the past four quarters, increased spending on health services accounts for 34% of the increase in real PCE. Over the four quarters, real PCE increased 2.5%, while real spending on health care services increased 5.2%.

Expect the Growth Gap to Grow In the Future

Even if real GDP grows at an annual rate of 3% through the end of 2016, the size of the growth gap will be larger at the end of President Obama’s term than it is today. This would occur despite the fact that the gap compared to the average of other recoveries includes the entirety of the “Great Recession” and the deep recession of 1981-82.

A Note on Creating Faster Economic Growth

Earlier today, the House Ways and Means Committee reported legislation making bonus depreciation permanent. Fixed business investment drives private sector job creation. History shows us that when businesses invest, they also hire new people.

Yesterday, Chairman Brady released a Republican Staff Analysis entitled Bonus Depreciation – Reducing the Growth Gap. The analysis is available on the JEC Republicans web site. New investment increases the output potential of the economy. For example, the Tax Foundation estimates that making 50% bonus depreciation permanent would expand the capital stock by more than 3%; increase the size of the U.S. economy by 1%; raise real wages by about 1%; and create 212,000 jobs. Moreover, making bonus depreciation permanent would actually increase federal revenues over the long run because of increased economic activity.